Severe Austerity Measures in Eurozone Producing Opposite of Desired Effect

I’m all for fiscal discipline and spending within one’s means, but austerity measures as medicine for fiscal discipline can literally kill the patient.

I have no doubt: the U.S. economy will feel the ramifications of what transpires in the eurozone. Make no mistake about that. (See: Payback Time: Europe to Export a Recession to America.)

I have been talking about the horrible unemployment rates recently in the eurozone, but there are other developments concerning austerity measures that warrant watching.

There is no question that the countries of Greece, Portugal, Ireland, Spain and, to some extent, Italy have spent beyond their means. Germany and France have instituted strict policies—austerity measures—these countries must abide by in order to receive future bailout money.

This is understandable and makes complete sense. Fiscal discipline must be the order of the day. Obviously if your son or daughter spent more than they earned and came to you for money, you would demand they cut spending—your own version of austerity measures. (I wish the administration here in the U.S. would initiate some austerity measures, like balancing the budget, but I digress.)

The problem with these austerity measures is that they prevent growth and, in some cases, actually assure that an economy will contract.

Here are two examples. In order for Greece to receive the next bailout money from eurozone, the country has been asked to, among other austerity measures, cut 15,000 government jobs in 2012, eliminate 150,000 government jobs by 2015, and reduce the private-sector minimum wage by 22%.

Once minimum wage is cut, those people affected spend less and pay fewer taxes, which results in less government revenue.

If the 15,000 jobs are eliminated, then these people pay no taxes to the government and, worse, receive some unemployment benefit from the government instead. Furthermore, these people cut their spending dramatically, which leads to the economy slowing. It’s a snowball effect.

What have the austerity measures done for Greece thus far? The country’s manufacturing output contracted by 15.5% in December, from the same period last year. Greece’s industrial output contracted by 11.3% in December. As a consequence, unemployment has jumped to 20.9%. Greece’s economy has now contracted for five consecutive years!

This, dear reader, is what a death spiral looks like.

Portugal has been the model country thus far. Since the crisis hit, the country has implemented the austerity measures that have been asked of it by other eurozone countries and, therefore, has received the bailout money from the eurozone to date.

Even though it is playing by the rules, Portugal’s debt-to-GDP is growing from 107% in 2011, to a projected 118% by the end of 2012. Is this because the country is growing its debt? No. Portugal has followed the austerity measures and has not increased debt.

The problem is that Portugal’s economy continues to contract. The austerity measures mean more people out of work or a cut in salary for those still with a job. That translates into less money for the government.

These scenarios are playing themselves out in Spain and Italy. These two countries are following the austerity measures, but their debt-to-GDP levels continue to grow, not because of debt, but because their economies continue to shrink. Italy’s debt-to-GDP was 105% in 2009, with the country now expecting 126% debt-to-GDP by the end of this year!

The protests are mounting. There is a breaking point somewhere not too far down the line with these austerity measures. If the eurozone breaks apart because countries like Greece, Spain, Portugal or Italy leave the euro, the U.S. dollar will not be the winner. Because the U.S. dollar is backed by so much debt, because the U.S. economy will suffer from of the demise of the euro, the only currency that will really benefit is gold bullion.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average closed yesterday only 100 points away from 13,000. How about this theory, my dear reader…

Greece gets its second bailout, the euro takes off on the news, the U.S. dollar falls, and the Dow Jones Industrial Average breaks through 13,000. Everyone is happy. Stock advisors turn solidly bullish and then, bang, we finally get that final blow off for the bear market rally. Just a thought…

What He Said:

“The proof that the party is over in the U.S. housing market could not be clearer to me. The price action of the new-home builder stocks is telling the true story—these stocks are falling in price daily (and the media is not picking it up). Those who will hurt most when the air is finally let out of the housing market balloon will be those buyers that bought in late 2005. In fact, the latecomers to the U.S. housing market may end up looking like the latecomers to the tech-stock rally that ended so abruptly in 1999.” Michael Lombardi in PROFIT CONFIDENTIAL, March 1, 2006. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.